Four Lessons Discussed - Weekly Blog # 877

 

 

Mike Lipper’s Monday Morning Musings

 

Four Lessons Discussed

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 Farmers’ Experience Led to the Crash

Is 1930 a preview of 202x? To set the stage, the 1920s were a period of transition and economic expansion. America and most of the industrial world enjoyed meaningful economic progress spurred on by the encouragement of increased debt. Governments, companies, individuals, and farmers used the resources of others to leverage their assets with increasing debt, fulfilling their perceived needs at ever increasing rates. The lessons of the 50-years before WWI were distant memories.

 

Due to WWI mobilization, women entered the workforce in increased numbers. The returning military found farm work too hard and too poorly paid on the farms. Financial communities, which had extensive experience with debt and leverage, found vast new markets for the financial skills of banks and others. Thus, the missing manpower was replaced by expensive machines and chemicals, which led to farmers owning leveraged machines and farms.

 

The age-old problem with leverage is the cost-price spread abruptly narrows. In a world becoming increasingly more global, international trade becomes the fulcrum-point of the fluctuating cost-price spread. To protect those in the middle from price swings, tariffs and other restrictive measures were introduced.

The US consumer desired ever-increasing amounts of food, with much of it imported from lower cost countries. To protect home-grown crops, additional costs and restrictions were placed on imports. Exporting countries fought back by lowering their prices to a point where domestically produced products could not compete effectively. Consequently, domestic farmers got their elected politicians to impose tariffs on imports, like the Smoot-Hawley tariff that President Hoover was reluctant to do. (It was repealed three years later) Other nations reacted by imposing their own tariffs on US exports, which was a contributing cause for WWII. 

 

What will be the impact of the proposed Reciprocal Tariffs being proposed? Despite what is being said, it seems unlikely consumers will avoid some or more of the cost.

 

Learning from Uncle Warren

This weekend Berkshire Hathaway (*) published its results for the 4th quarter and all of 2024, along with a well thought out discussion. The company has four main revenue sources for the heirs of its shareholders. Berkshire has total or partial ownership of over 180 private companies and a smaller but better-known portfolio of quite large publicly traded companies. They also have an increasingly large portfolio of short-term US Treasuries, which increase in value as interest rates rise.

 

The difference between what their insurance companies charge and their eventual payout is called a “float”. In the most current period all earnings asset categories rose, except for the holdings of the publicly owned securities which declined because of sales. The total portfolio rose and is selling very close to its all-time high. Considering the company announced it is being managed for the benefit of today’s shareholder heirs; it is extremely appropriate to occasionally reduce its near-term market risks. (It is worth noting, the remaining two lessons in this blog suggest caution is warranted.)

(*) Owned in Personal and Client accounts

 

The Leading Mutual Funds Suggest US Risk

Each week I look at over 1500 SEC registered mutual funds, as well as many more in the global world. Usually, a number of different drivers describe the leaders of the week.

 

The list below shows the investment objective assigned to the fund:

Precious Metals Equity           21.04%

Commodities Precious Metals      11.86

International Large-Cap Value     8.60

International Mid-Cap Value       8.54

Commodities Base Metals           8.34

International Large-Cap Growth    8.24

Commodities Agriculture           8.15

Warren Buffet, among others, is concerned that the US government may cause the value of the US dollar to drop.

The year-to-date winners are not investing in the US.

 

“Debt Has Always Been the Ruin of Great Powers. Is the U.S. Next?”

 Above is the title of Niall Ferguson’s article in Saturday’s Wall Street Journal where he introduces Ferguson’s Law, which was crafted in 1767. The law states “that any great power that spends more on debt service than on defense risks ceasing to be a great power.” According to the author, debt service includes repayment of debt and defense includes all costs to maintain the military. The US has just passed this milestone, but it would take an extended period to fundamentally break the Ferguson Law.

 

Working Conclusion

Be careful and share your thoughts, particularly if you disagree.

 

 

 

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Worth vs Price Historically - Weekly Blog # 821

 

Mike Lipper’s Monday Morning Musings

 

Worth vs Price Historically

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

Merchants Needed

Despite what many believe is the oldest profession, growers and herders were the first tribes to survive. As both tribes frequently had more of their own product than necessary, they needed to exchange their excess production with members of the other tribe. Both tribes were skilled in their own production but did not fully understand the other tribe’s costs. Initially, the agreed price was in terms of quantities between the two commodities (x sheep for y bales of cotton).

 

Fairly quickly, solely mathematical terms of exchange (3x for 5y) became insufficient in terms of defining the starting quantity and conditions of transfer. The exchanging parties often did not know or trust the other party. Thus, there was a need for a middleman to determine an agreed price between buyer and seller. The middleman would necessarily be known or recognized by the would-be traders as someone who could be reasonably trusted and was capable of developing accepted terms of trade.

 

With buyers and sellers geographically separate, both in terms of distance and possibly language, the value of a somewhat trusted third party became even more important. Still further elements became essential, a recognized type of money, or later, credit.

 

Over time, the third parties evolved into merchant houses or merchant banks. When dealing across borders and cultures the participants were often happier if the money or credit exchanged was issued by a bank, especially if the bank backed by a government with a wealthy family behind it. At this point these transactions utilized money in the form of coins convertible into known quantities of precious metals.

 

Foreign Exchange

When the western world was ruled by Rome, the value was understood to represent an understood bundle of goods and services. This worked well when the government controlled the coinage. A problem arose when government expenses for war or extravagant expenses rose beyond an acceptable level of taxes paid. A conflict that exists today.

 

Governments addressed the problem by gradually debasing the currency, such as substituting copper and other base metals for precious metals. As governments did this differently, the purchasing power of their money became dissimilar to one another, both in ancient times and today.

 

Those who suffer from a liberal arts education are taught incorrectly that the English Magna Carta was forced by the public on the English king. The real cause resulted from the Barons revolting against the increased tax load on their land. The increased tax load was caused by the expense of the Crusades and the ransom paid for the release of their king who was held hostage in Europe.

 

Today our federal government is changing the rate of taxation and how it is applied to both income and estates. Since foreigners derive earnings from activities and trade in the United States, they react by reducing their exposure to the US dollar, reducing its value. This is currently an issue for an investment committee on which I sit. In looking at our portfolio and foreign expenses at the last meeting, I suggested we begin tracking the changing value of the dollar. It is also something I need to do in looking at portfolio selection.

 

A Historic Portfolio Change

(Please do not take this discussion as a recommendation, as that requires careful analysis of the needs of an account. T. Rowe Price is held in a personal account and some client accounts.)

 

The man, T. Rowe Price, started his investment counsel firm in 1937, a year of a few months of gains in a period of stagflation. Mr. Price was one of a few managers investing in growth stocks at the time. Sometime after the conclusion of WWII he became concerned that the inflationary habit had taken over management of the economy and by 1979 he was disturbed about how the US was doing. He started managing money to graduate from FDR’s New Deal, implementing a philosophy he called New ERA in a new fund concerned about government led inflation. In 1979 George Roach became his assistant, and I believe in 1997 he became the portfolio manager. He later became President of the firm. George kept with Mr. Prices’ concerns, but he allowed the rest of the firm to continue with their growth stock orientation, which produced a very commendable record.

 

Prior to December 2023

The T. Rowe Price New Era Fund was managed with extreme consciousness of inflation. This translated into investing in common stocks of companies expected to rise in the future as inflation rose by investing in assets, not earnings. Most followers of the New Era fund viewed it as a commodities fund because that is what the portfolio looked like.

 

Shinwoo Kim has been the portfolio manager for New Era since 2021 and has been with T. Rowe since 2009. He has proclaimed that commodities have been and are in a long bear market ever since he became portfolio manager, but that changed in December. On the first of December hea as portfolio manager of New Era affected a considerable change in its portfolio, returning it to Mr. Prices’ basic concerns.  

 

Kim feels the US has migrated to a world where inflation and excessive federal government spending is the principal driver of investments. After ten years he has concluded, and convinced the rest of his investment committee, that the commodity cycle is about to change. He expects future investments to benefit from cyclical earnings growth, which will produce better results than ownership in highly valued assets.

As a natural resource fund New Era has not done poorly, compounding at +2.97% compared to the average Natural Resources Fund’s +2.69% over the past ten years. I suspect this outcome was largely the result of its yield, not earnings or Price/Earnings expansion and/or P/E expansion. (The result was not measured against the changing value of the dollar.)

Economists have tagged the price of copper as Dr. Copper. As the price of copper has performed better than most economists over time. The use of copper by the electrical/electronic industries and construction activity gives its use a cyclical growth trend. Other structural changes expected to benefit the portfolio include Uranium and US shale production. The fund believes the long-term outlook for production in Marcellus/Utica as well as Permian is understated. Additional attractive areas for investment include industrial gases and pipelines. (This brings to mind Berkshire Hathaway- a position owned in our personal and managed accounts)

 

 

 

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My Outlook: Nervous Balances - Weekly Blog # 767

 

Mike Lipper’s Monday Morning Musings

My Outlook: Nervous Balances

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 

 

Nervous Dilemma Positioning

My traditional allocation of stocks and bonds being close to a 70/30 split is somewhat misleading. A significant minority is in actively managed stock mutual funds with a financial services or international focus, often Asian. Financial services need a better label, so as to include two stocks of companies that are building their own portfolios that behave similar to variable annuities, Berkshire Hathaway and Apple. (The reason to call them annuities is that they are both primarily managed to produce long-term earnings, rather than current earnings.)

 

Financial services holdings as a group are also expected to fully participate in the growth of the US and International economies. In general, their strength is not in making loans, but in making money with equity. Consequently, one might characterize my equity investments as a combination of growth and value in more classical terms. This is appropriate as most companies have spurts of growth and value.

 

Time Horizons

For both my professional and personal/family accounts I start by designing portfolios built on an understanding (guess) of when and at what frequency the proceeds of the account will be delivered.

 

My particular situation is that I have a younger and healthy wife, with the fourth generation of the family begun. We are also committed to supporting the operational needs of a limited number of non-profits that Ruth and I have been involved with, both as volunteers and donors.

 

Short or Deep Recession?

I tend to look at various down periods through the late reporting of real net income (inflation/foreign exchange adjusted). Where possible, I prefer to use net operating income. Since 1970 the US has suffered 8 major declines of real reported income (-15% to -41%), with a median decline of about -28.5%.

 

The popular view today is that if we have a declared recession, it will be short and small. As someone who learned about odds at the New York racetracks I am nervous with popular views. Their payoffs are too small compared to the pain endured in the prior decline.

 

One theory of economic/market history is that declines are caused by imbalances, which are addressed during the recovery. If that pattern is followed in the next recovery, we may not yet have gone down enough. We need more time before the correction begins.   

 

The current path of major central banks is to follow the Federal Reserve Bank in attacking the supposed major cause of inflation with the only thing they can, short-term interest rates. The best definition of inflation is too many dollars chasing too few goods/services. The last two administrations contributed to these excess dollars, which were officially used to cushion the public’s loss of pre-COVID income with grants. (This was similar to the ancient Romans using bread and circuses to bribe people.) They are still at it!! This will make the Fed’s job more difficult and expensive.

 

Fewer people working should also drop the level of demand. However, despite all the increased regulation and required business spending, there are approximately 1.7 employees wanted for each current worker. This has created a situation where job switchers earn more than those who stay put. (If one really wanted to eliminate excess demand you could simply reduce restrictions on business.)

 

Thus, a shallow recession could be shorter if the federal government wasn’t playing both sides against the middle. This may happen later this year with their hope of a meaningful recovery by Election Day 2024.

 

Assuming this case, financial markets could start up as soon as economic indicators hit a bottom, with smaller declines. Which could happen this year. If this were to happen, our 70% equity stock fund portfolio would produce a nice but not great return. One area to consider for investment are funds that have lost money over the last 10 years through January 12. In general, these funds were victims of a strong US dollar. Included are funds invested in commodities, emerging markets based in local currencies, Latin Americas, and precious metals.

 

Second through Fourth Generations

While a recovery based only on lowering inflation and interest rates will generate returns for my wife and me, it would have little impact on succeeding generations, including various long-lasting charities.

 

The larger and longer-term problems that will reduce returns for succeeding generations will not be addressed by the level of interest rates. Most of these problems are related to people rather than numbers. These problems could be expressed as “Better for customers, workers, and owners”.

 

Below is a brief list of imbalances that should be addressed:

1.  Quality of leadership in each sector and operating unit of society, including levels of governments, segments of health and medical, education, and non-profits.

2.   Middle-class income as a percent of national income returning to levels of the past.

3.   Measured and productive population growth.

4.   Appropriate education for current and future needs.

5.   Governments of the people, by the people, and for the people.

 

Perhaps for the benefit of succeeding generations the appropriate investment strategy should include less exposure to risk until there is a deep enough decline to correct for imbalances.

 

Please tell me what you think?

 

 

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Pick Investment Period & Strategy - Weekly Blog # 737

                                    

Mike Lipper’s Monday Morning Musings

Pick Investment Period & Strategy

 Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

This is the 737th blog which shares my thoughts on different investment periods and strategies. They are different from each other and are partly triggered by Friday’s US stock market decline, which in the extreme took 10% off the average price of narrow industry groups.  The views expressed are for the beginnings of internal discussions, not final conclusions which I would be happy to discuss.

Last Week

The 8:30 am Consumer Price Index (CPI) shocked some market participants, but really shouldn’t have shocked those who’ve visited retail locations. From the opening bell until the close stock prices fell. A significant price gap developed between Thursday’s close and Friday’s prices. Most of the time, significant price gaps are closed in subsequent trading before a change in direction continues.

Bullish traders could be overjoyed by Friday’s price action, which showed a considerable increase in volume. They will look at the result as a successful test of an earlier low price.

During the coming week the Federal Reserve will have a regularly scheduled rate setting committee meeting. Prior to Friday’s price decline it was generally expected to be a 50-basis point interest rate increase. This may happen, although the key for the market is not the rate but the issued statement. Some think the market move may scare the Fed into raising rates higher or lower and could also change the announcement related to cutting assets on the balance sheet. 

Market analysts are focused on the price level of the S&P 500 (SPX), whose prior low point was in the low 3800 level. If it were to be breached, a “bear-market” would be called. Some believe the ultimate SPX decline could be in the 3000-3500 range,

Hopefully, what transpires doesn’t mirror Boeing’s launch of an essentially brand-new plane following their very successful 737. Early on, the new plane had some crashes.

July Numbers Difficult to Interpret

• Market sentiment was largely positive in the first half of June, then turned negative in the middle of the month.
• Interest rates on non-government paper rose as retail sales dropped.
• Government numbers focused on a middle of the month week and probably didn’t fully recognize the deterioration of conditions.
• If the very current sentiment continues, I expect the reports for June, published in mid-July, to show a further decline in sales and a gain in inflation.
• If the second quarter GDP is like the first quarter, it will be the second consecutive quarter of contraction, the definition of a recession. 
• For the latest week, six of the ten commodity rail-carload groups showed declines: Other -15.4%, Metallic Ores and Metals -13.5%, Petroleum and Petroleum Products -7.6%, Farm Product and Food -5.6%, Forrest Products -2.9%, and Coal -2.0%. Total Intermodal -4.4% and Total Traffic -2.8%. (As these represent sales to customers, they denote current market activity not building inventory by the producers.)
• The level of interest rates in part deals with expectations. Thus, read what Randy Forsyth in the current Barron’s wrote. “If interest rate expectations are still too low and earnings forecasts too high, don’t be surprised if stocks get sliced further.”

Stagflation

• The World Bank is warning that the global economy may suffer 1970s style stagflation. According to them, it is possible world growth could be close to zero over the next 2 years.
• There is a view in many “advanced” countries that the will of principal taxpayers is to not follow their spendthrift governments by increasing their debt load in a slowing economy.
• According to some economists, the US suffered stagflation between 1973 and 1982. (I started Lipper Analytical in 1973) 
• Frankly, I don’t fully remember the period as I was quite busy building the firm and growing the family, so I asked an associate to research which mutual fund peer groups did best and worst. 

For the ten years ended in 1982 the top 5 peer groups in aggregate were:

       Precious Metals        +346.74%

       Convertibles           +220.51%

       Small-Caps             +214.81%

       Equity Income          +181.63%

       Growth & Income        +156.10%

Except for Growth & Income, these funds groups did not attract a lot of assets. The growth in assets was below $1 Billion in total, indicating the bulk of the industry produced good savings products, but not great investments as a group.

The five worst performing peer groups were also not popular with investors. Their 10-year performance is shown below:

        Short US Government   -10.22%

        Natural Resources     +23.37%

        GNMA               +56.11%

        Financial Services    +57.15%

        Miscellaneous         +64.43%

• To find individual fund groups that were extreme performers we looked at the two best and worst for each year. Not surprisingly there were only a few repeaters.

The most consistent winner were Precious Metals funds, at the top five times but also at the bottom three times. This seems appropriate in a period of rising inflation. Not surprisingly, Global Natural Resources finished at the top for two years. (During periods of high global inflation escaping out of fait currency makes sense. However, one needs to recognize that a greater fool theory game is at work, requiring quick sales to avoid losses.) We don’t have enough history and court cases to determine whether crypto related assets are better.

Where Are We Today

We have had a remarkably productive ten years in the market, but recently there has been great damage done to the ten-year performance records. (Unfortunately, my data does not include Friday’s painful numbers.) To over-correct in looking at the ten-year mutual fund performance record, I have eliminated peer groups gaining less than 10% per annum. 

I found 17 peer group averages that produced compound growth rates from 10% to 16.96%.  They are listed alphabetically below:

Capital Appreciation   Global Real Estate

Consumer Goods         Health/Biotech 

Consumer Services      India Region

Energy MLP             Micro-Caps 

Equity Income          Mid-Caps 

European               S&P Index 

Financial Services     Science & Tech

Growth & Income        Small-Cap 

Global

I question whether many regional fund groups can continue better performance than selective global competitors for long periods. Past performance is a useful research screen but cannot be solely relied upon due to changing conditions.

One change due to both bank and market regulatory modifications is the level of trading desk liquidity. It is shrinking and depending on the size of the trading relationship, access is uncertain.

Another concern is the needs and desires of consumers conflicting with the political desire for jobs. Both European and US governments appear to prize job creation over consumer needs for the best products and prices. This trend aggravates supply shortages and causes unnecessary inflation

Unaddressed Trends Can be Problems

We have been told that demographics is destiny, yet we are not paying attention to the message it is sending. Liz Ann Sonders of Charles Schwab tweeted the following:

In 1952 the average global family had five children, now they have less than three. Following is the number of children per family in various countries: Niger 6.7, Nigeria 5.2, Senegal 4.5, Ghana 3.8, Pakistan 3.4, World 2.4, Mexico 2.1. The replacement rate in the US is 1.8 or lower and it’s 1.1 in South Korea (Within many people’s lifetime, India will have more people than the shrinking population of China. 

These numbers have long-term military, economic, and investment implications. What can be done about these trends?  One of the lessons from the US Marine Corps is to get the best possible troops on your side. Economically, the founders of Unicorns are the most productive people we have. (Unicorns are start-ups that become worth $1 billion or more.) The founders top 6 academic majors of these unicorn are in order:

Computer Science

Engineering

Business

Economics

Biology

Mathematics

Students who successfully take and complete these courses are used to precision and discipline. They learn at home or at an early age. We need more of these students to offset the eventual power of those growing societies.

Please Share Your Thoughts

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

https://mikelipper.blogspot.com/2022/05/bear-markets-recessions-not-inevitable.html

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

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Inconclusive, But Trending Lower - Weekly Blog # 733

                                    

Mike Lipper’s Monday Morning Musings

Inconclusive, But Trending Lower

 Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

We Want Clarity

In truth, we don’t know what the future holds for us, our families, country, world, and oh yes, our investments. In terms of the US stock market, we are searching for a sign or a group of signs giving us the courage to act, hopefully before others. I am an optimist and a contrarian, based not on personality, but arithmetic. Markets spend most of their time trending on average in one direction or the other after turning points emerge. Those of us who find bull markets more pleasant and profitable than bear markets are in search of a turning-point. We have been conditioned to at least anticipate the end of a directional move before a major reversal to a new one. This makes sense because turning points occur when there is a dramatic difference between buyers and sellers in their transaction volumes When this happens an emotional low or high point is reached, although an actual low or high often happens on a different day with materially less volume. Historically, lows and highs are tested at least once, if not multiple times, without establishing new highs and lows. This week was not such a turning point in my opinion.

The Week Ended Friday the 13th of May

On the New York Stock Exchange (NYSE), 47% of the stock listed reached a new low. Similarly on NASDAQ, 49% reached a new low. Perhaps more convincingly, the volume of declining prices was about twice that of rising prices on the NYSE (16.6 million vs 7.9 million); whereas on the NASDAQ it was about three times (15.0 million vs 5.1 million). The plurality of the selling was more dramatic than the indices dominated by large caps. (Dow Jones Industrial Average (DJIA) -6.36%, S&P 500 -2.41%, and NASDAQ Composite -2.8%). Perhaps the relative performance of mutual funds reflects the extremes of fund shareholders’ fears. The best performing large sector was US Treasury Funds, with the weakest being Precious Metals Funds.

Intermediate-Term Outlook

Prices, interest rates, and yields reflect participant feelings about current levels and their impact on future results. The Producer Price Index (PPI) read +15.68%, the JOC Industrial Price Index +9.47% (already starting to fall), the Consumer Price Index (CPI) +8.24%, Inflation 4.21%, and the Broker Call Loan rate 2.75%. What could be more indicative are fund flows into Chinese domestic funds, which almost doubled this last quarter from their 2nd quarter in 2021 (816 billion RMB vs. 456 billion RMB).  

Other concerns include the S&P 500 declining for the first four months of the year, as most of the time the remaining 8 months cannot break even for the year. For some time market capitalization has provided a good clue to stock price performance, presumably because the large-caps are more liquid. However, when analyzing fund performance by market capitalization this week, there does not appear to be any appreciable difference in year-to-date performance.

Longer-Term Concerns

Secretary Yellen is pushing a minimum global corporate tax, part of the redistribution effort in the US and an effort to destroy sovereignty. Our contacts in Washington suggest these proposals will have difficulty passing the US Senate. The mere fact that it is being proposed generates a market and economic negative that worries some.

Initial Thoughts About the New Bull Market

As usual, I am premature in thinking about the future. Because it takes me a long time to research and make up my mind, I need all the time and help I can get from subscribers and others. Below are a few briefs of my thoughts, which I hope will spark a response.

• Service companies look to be better than goods companies due to the limited amount of talent available. This will lead to favorable pricing.
• Invest in countries and people that are honest, save, and are believers in a practical education.
• Invest in technology that uses new ways to solve problems.

Please share your thoughts now, even though we probably have considerable time before the new bull market comes. The new bull market will probably be led by other names than the old.

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/05/havent-found-bottom-yet-investments.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

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Current Causes of Concern - Weekly blog # 716

 

Mike Lipper’s Monday Morning Musings

Current Causes of Concern

(I would like to be wrong)

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

In our first blog of 2022 I suggested this might be a troublesome year. While most predictors tend to forecast their wishes, it says more about them than being useful. The most useful predictions are perhaps expressed in a fanfold display, with at least three lines originating from the current origin to a future date. The graph offers at least three possible paths forward: high, medium, and low. My faulty crystal ball is not up to that model. My current outlook is negative. Perhaps it is my military training, when I assume a position of responsibility and search for all possible attack routes. Following this process, there are immediate causes for concern for our investment portfolios. (As already noted, I hope I am wrong.)

The causes for concern come from my weekly review of both data and news reports. You can interpret any or all these factors negatively or positively or view them as unimportant. I leave it up to our subscribers to make their own judgement and hopefully share their views. The concerns are listed in the order I came across them, not in order of importance. In parenthesis and in italics after each item are my worries.

1. Most commentators are focused on the expected moves by the Federal Reserve Board regarding interest rates and the disposition of their large portfolio of debt instruments. (I expect the Fed to continue its traditional role of being late in changing direction, confirming trends already in motion rather than signaling a change in direction. This view originates from the reality that the President nominates the Fed Governors, which in turn are confirmed by the Senate. This week, three people with no apparent experience of working in a bank, a commercial profitable enterprise, or managing money as a fiduciary, were nominated. Despite the Fed being an independent agency, it is very unlikely it would take a point of view opposing the President. Many investors believe rapidly rising interest rates are largely due to the accommodative policies of the Fed under the current and prior President. Inflation results from many other imbalances in the domestic and global economy. Under the current circumstances I am concerned.)
2. In the latest week through Thursday, 11 of the 25 top performing mutual funds were precious metals funds, with 7 of the 10 worst being growth-oriented funds. (The stocks in these portfolios are moving in the direction suggested by a high inflation and short-term focused stock market.)
3. One of the oldest predictive approaches to the equity market is the Dow Theory. For continuation of the current trend, it requires the Dow Jones Industrial Average and the Dow Jones Transportation Average to be going in the same direction, with each index confirming the high of the other. The Transportation index has been declining since November, while the Industrial average has gone on to make a new high. (If the professional buyers of transports believed the ordered clearing of seaports would solve rising inflation, the index would be rising.)
4. The old Journal Commerce Index of Industrial Prices continues to rise, gaining 2.7% this week. (Inflation is broader than consumer prices, transportation costs, and excess money supply growth.)
5. The Barron’s Confidence Index is predicting bond prices performing better than stock prices over the next six months. (This rarely happens and is a sign of an equity bear market)
6. Robert Lovelace, a senior official and portfolio manager of the highly respected Capital Group, pointed out that we are in the 11th year of an equity market expansion. A significant contributor to its rise being the increase in price/earnings ratios. (Earnings of companies typically change more slowly than valuations. Consequently, we can have a down market with flat to rising earnings when valuations decline.)
7. The largest contributor to global trade growth is China. Compared to the US, China is a controlled economy. Even with all its controls, results are slipping. (Without China’s need to import high quality goods, services, and energy, the exports of developed countries will decline. This is important for the US, Germany, Italy, Canada, and Australia, among others which supply imports into China.)
8. Bond owners suffered volatility risks greater than 5 years interest payments in January. (If the bond market is at risk, it is also dangerous for global stock markets. Most equities are leveraged by the amount of fixed income borrowed. There are many highly leveraged positions in high-quality bonds.)
9. Ukraine‘s unequal position versus Russia’s 100,000 troops on the border is dependent on international cooperation for a resolution. (Is Putin betting on the probability the US and others will not commit troops? The belief that curtailing Russia’s use of the SWIFT currency transfer system will be an effective deterrent, does not comprehend the historic practice of enemies at war. Enemies regularly trade with each other through third countries, as happened during WWII. The way we exited Afghanistan and left many promised entry into the US behind questions the strength of the US word.)
10. Growth in the use of Private Equity by public pension funds and wealth managers for individuals broadens the potential risk to investors, who don’t have sufficient knowledge of these investments and what can go wrong. (It is just another example of performance chasing rather than anticipation.)
11. Barron’s wrote positively of 105 stocks gaining 5.1% on average in 2021, vs the relevant averages which gained 8.4%. They were more successful with four bearish recommendations. The choices of the “experts” who participated in their annual round table also underperformed the market. (Picking investments is a difficult task. It is easier to pick winners and limit losers by choosing portfolios, but they will often fail to beat individually selected stocks that are big winners.)
12. The J.P. Morgan Chase earnings call celebrated the published numbers, while discussing each of their main activities properly outlined current problems. While it is arguably the best large bank in the world, they have possibly reached a cyclical high in many activities, which won’t return until there is some real continuing growth in many economies. The 6% drop in JPM’s price on Friday appears to be appropriate. (Perhaps JPM is topping out, like the US is doing under Putin’s judgment. Xi may share this view, considering his plans to deploy four aircraft carriers vs only one for the US in the waters near Taiwan over time.) 

None of these concerns need be permanent, but investors likely face some troubling times ahead. The possibility of multiple negative events unfolding simultaneously is a big concern. We have a toxic mix of increasing inflation, high valuations, extremely low interest rates, a slowing global economy, and a dangerous geopolitical environment. Having people appointed for purely political reasons is always a concern, but especially at a time like this when perspective and skill are required. 

Inflation will only be beaten by taking the necessary corrective measure to raise interest rates and slow the spending. There will be political pressure to do otherwise. Taking the corrective measures necessary will likely be painful and politically damaging, a reason it will not likely be done to the extent necessary.

Valuations will likely return to normal faster than most expect, although that’s cold comfort for most investors. A generation of investors knows only rising markets and that has led to complacency. 

What do you think?

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/are-investors-taking-too-much.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

What Is The Problem? - Weekly Blog # 702

 

Mike Lipper’s Monday Morning Musings

What Is The Problem?

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Where are we?

As we enter the third quarter, often a good performing quarter, US stock market volume is underwhelming. Apparently, declining confidence in global political leadership has led to a fall in investor confidence. In the latest week, each of the six best performing funds had a different investment objective. In fund performance order they are: Managed Futures, Flexible, Tech, Financial Services, Natural Resources, and Precious Metals. This suggests no common theme or the likelihood of similar stock positions. Thus, success is likely the result of critical skill in stock selection, not sector or market selection. A similar focus is seen in fixed income, where corporates are outperforming governments.

The American Association of Individual Investors (AAII) weekly sample survey of members is showing no enthusiasm for either a bullish or bearish future for markets. This survey is often a reliable contrary indicator for the next six month’s performance. Of all the indicators reviewed, the only one that’s relatively strong is the Barron’s Confidence Index, which favors stocks over bonds.

In general, I believe actions speak louder than words, particularly from members of the investment/financial community. This week I am seeing an increasing number of respected firms uprooting their employees and moving to Texas or Florida, not just for lower state taxes but for a better lifestyle. In addition, within the fixed income world there has been a considerable shift of investment people from one well known large employer to another. I am also noticing various product lines being transferred from one insurance company to another in the insurance sector. There are undoubtedly specific reasons for each of these shifts, but underlying each shift there appears to be a view that the future will be better for employees and their clients at their new firm. 

Should we be looking at longer periods and seeking different clues? There are brief lessons from Rome, Netherlands (vs Spain), England, and the USA. If we apply these and other lessons, we can handle our competition with China long-term.

Rome

For hundreds of years Rome was the dominant power in Europe, North Africa, and the Middle East. It was the technological leader of the world based on its mastery of building roads for military chariots and commerce. Rome was also the builder of aqueducts bringing water to Mediterranean cities. 

Rome was brought down by its own invention of “Bread and Circuses”. The political powers in Rome provided bread and free entertainment to its supporters in their arenas (circuses). In effect these were bribes. These “gifts” to the population of Rome, the tributes from conquered lands, allowed many Romans to not work. The history of great empires like Rome is that they fell due to internal pressures and the unwillingness to properly defend themselves. Thus, the great Roman Empire was defeated by bribes that weakened their will to survive.

Netherlands

The country fought a series of wars to free itself from the threat of occupation by the much larger and richer Spain. It was essentially a war between Spain, with its import of Latin American gold wealth, and the aggressive Dutch merchants who worked together. (One of the classic paintings of this era shows a group of merchants serving as night watchmen to alert their community to the danger of fire in their midst.) These merchants were inventive, creating the first stock exchange. They were also early in developing funding vehicles such as trading companies servicing their established colonies in South America, Asia, and Africa. Robeco also successfully built the first self-managed and owned mutual fund, way before the late Jack Bogle’s Vanguard. 

When I was a junior security analyst at Burnham, there was great respect paid to the firm’s Dutch clients who were believed to be very savvy judging risk. (I remember commenting on one occasion that the Dutch were selling shares in a Dutch international company to the Americans. It seemed to me that the locals were right, and they proved to be.) 

From a small geographic base and only a merchant fleet, they established a number of large international companies and colonies, without the benefit of a strong military. This proves that under the right circumstances merchant power and expertise is equal to or better than a strong military base. Even today, Dutch financial companies “punch” way above their geographic weight.

England

England, or more precisely the United Kingdom, is another former global empire from a small country with limited natural resources. Like the Dutch, they were early in building a savings industry, which is now a world financial power. The country has also produced more legal principles than any other in the world. While The Magna Carta was only between the King and Nobles, it proved to be the foundation of the concept of limited government. 

The English did something few countries have done, passing the crown three times to leaders born outside the country, and it worked well. The political establishment has also yielded to a popular view other than the sitting government. (While we celebrate the US victory at Yorktown as the end of the American Revolutionary War, a peace treaty was signed in London before the battle even began. Without electronic communication, America had to wait for a ship to arrive with the news.) The change in London was led by prime minister William Pitt, the Younger, who deemed the war too expensive relative to the value of US trade. The long war was difficult to win, so the finest military and navy conceded. Only great leadership of a country has the strength to recognize changes have taken place that require a change in policy.

USA and Prohibition

Almost as soon as elections were held in the cities of this country, it was common for some political groups to offer alcoholic drinks to would be voters. A small-scale throwback to the “bread and circuses” of Rome, but still a type of bribe. When the temperance movement gathered steam I suspect it received some support from those who felt gifted alcohol on election day may have changed some votes, particularly in big cities with lots of new voters. 

Much like with William Pitt, the Younger, popular opinion turned against prohibition when policies needed to be changed in the 1930s. It probably cemented the “wet” politician relationship with bootleggers, speakeasy proprietors, their suppliers and customers. Even after Prohibition, the only places in New York state to get a drink on election and primary days were locations independent of New York law, the Indian reservations and the dining room at the United Nations. This demonstrates the US can change policies when the perceived facts change.

China

I believe the current leadership in China is largely consistent with its history, demographics, and its financial structure. Approximately 90% of the people living in China today are descendants of the Han Chinese, the remaining 10% comprised of approximately 55 other national groups. While many of these groups have lived peacefully in China for hundreds if not thousands of years, they are viewed as potentially disruptive by the central government. Based on these concerns I believe the government does not want to add new nationalities into China. Because the Nationalist government fled China, they view Taiwan as largely Han Chinese. If I am close to correct, I do not believe Xi wants to occupy other countries. However, it is afraid of being trapped by unfriendly neighbors. That is why they want them to be friendly and not be controlled by other world powers.

Xi has other problems, including incipient competition funded by some successful businesspeople. He is very conscious he’s in a race against time, with the population aging and not replenishing itself.  The Chinese are prodigious savers who’ve had little to spend their money on and a heritage of living rurally with weather/crop cycles. Within family groups and some small communities there is a combination lottery lending mechanism, allowing the winners to jump to a higher economic level. In aggregate Chinese savings are enormous, funding both business and various levels of government.

The best way for the US to become more competitive with China is in some respects to copy them. Currently, our political leaders measure our success by the amount we are spending on goods and services. Although this provides current value, some consumption has no value long-term, causing this country to fall further behind as a saving society. The US government should switch its emphasis to saving for the future, where we are very much underfunding retirement. Additional savings would push up savings income and attract Chinese investors anxious to diversify their investments.  They are all conscious of the risks in their own over leveraged society. 

If we are able to do this, we would accomplish what my wife describes as a double win, benefiting both the Chinese and the Western investor. Such an occurrence would generate a lot of confidence.

Why Now?

While many people talk longer-term, most of their psychic and financial income is relatively short-term, impacted by their own expected tax rates. The future is almost never crystal clear and for many it has become either less clear, less attractive, or both.

Near-term elections over the next three years may provide some answers, or they may not. It will depend on leadership characteristics changing from the standard politician’s focus on the next election and those of statesmen or women focusing on future generations.  

   

What do you think?    

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/10/the-confidence-game-weekly-blog-701.html

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

3 Thoughts to Ponder: - Weekly Blog # 698

 

Mike Lipper’s Monday Morning Musings

3 Thoughts to Ponder:

Where are We Going?

China in the Driver’s Seat?

Buy 1, 20, 100, 500, 2000

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Where Are We Going?

Most pundits who have expressed views don’t know where we are. Their view of the various markets is the last print of a summary index. While at times there is almost total uniformity to any statistical set, it is rare. Currently there are discernable cross trends within the stock, fixed income, and commodity markets. The latest high reading of the three most popular indices are quite different. The Dow Jones Industrial Average (DJIA) high close was reached on August 16th, Standard & Poor’s 500 on September 2, and the NASDAQ Composite on September 7th. This may suggest the cyclicals ’outlook is topping, as the size of future earnings gains compared to the prior quarter or a year ago quarter is not high enough to justify further increases in price/earnings ratios. While the S&P 500 contains cyclicals, core, and growth members, the underlying growth rate projections are starting to be lowered. The NASDAQ Composite is currently both a beneficiary and a temporary victim of supply constraints. 

High-grade paper is relative flat, while short-term high-yield paper is heavily sought after. In the bond market, government paper is attracting both foreign exchange players and GDP players.  

In the commodities arena there are vehicles reflecting capacity constraints, although precious metals mining stock prices are returning to the levels of the underlying metals. These dichotomies are showing up in many international markets.

What do these disparities mean? While I don’t know, combining these disparities with the low transaction volume suggests the markets are ready for a change. One or more of the following factors could be the excuse for sizeable transactions:

• Disappointing results or near-term expectations in 2021 revealing weaknesses in the 2019 economy.
• Expansion of COVID 19-2 delaying deliveries into 1Q 2022.
• Threatened income and capital distributions disincentivizing personal spending and investments. This could change capital expenditures and estate planning for generations.
• Geo-political actions, potential or real.

China in the Drivers’ Seat?

While the US is the largest economy, it is not leading the world. The US reacts to the political, military, and economic actions emanating from China, which leads the growth of world trade. Due to internal considerations, China’s central government is reducing its growth rate. On the surface it is due to concerns over the growth of debt generated by local and provincial governments creating employment for farmers migrating to the cities. 

Beneath the surface, Xi is very conscious of the history of revolts in China. The growth of economic power in the hands of a small group of business leaders could be the cadre for a rebellion, or at least a demand for shared power. The standard way to do this is to focus the population on the threat from the “foreign devils”. However, the on-shore and off-shore wealth of important party members cannot be ignored.

Thus, a conflict between Xi and Biden is a potential danger for the entire world. Both leaders face internal competition challenging their political power. The best way to eliminate this threat is to curtail the opposition’s political power by threatening its capital base.

There is however a different model that parents learn with the introduction of a second baby. The two babies at first ignore each other. (We are much further along in our Sino relations.) The next phase is one of parallel play, where the two babies do similar things. (We have done that for some time.) The next stage entails competition for elements of attention or geography (toys). (We are in this stage now in terms of markets, borders, waterways, and space.) The final stage is one of negotiated co-operation. If this is achieved, it means that in time the children will begin to dictate to the parents and the cycle begins again. (We are not there yet and may never get there, although the Biden initiated phone conversation was a surprisingly good first step in search of some elements of agreement. If the two leading nations of the world apply their combined strength, peace and market progress will last until others grow in capability. The next generations of the newly powerful; India, Indonesia, and Nigeria will possibly seek somewhat equal treatment). 

If we don’t get to the final two-party stage, we may need to hedge our bets, as neither party is going to have all the talents and assets to meet current and future desires.

Buy 1, 20, 100, 500, 2000

As is often the case, numbers are a code for reality. This thought occurred to me when I read a promoter’s pitch for an ETF with someone else making the security selection. I thought this a very naïve point of view, as any collection of securities, objects, and people move as the weighted power of the individual members, no longer paralleling any single member. What then does the number of stocks held portray about the collection? Is that what is wanted?

Perhaps the wealthiest investors are those that own all or a very large portion of a successful business. The trade-off for that exalted position is the responsibility to manage the asset correctly for the beneficiaries. 

Luckily for mutual fund holders, when the SEC developed the main governing law for mutual funds (Investment Company Act of 1940) they allowed the trade association and importantly their lawyers to develop the law at meetings in the Mayflower Hotel in Washington DC. As lawyers are prone to do, they focused on the risk of losing money. They concluded the best way to avoid the loss of all or a major part of a fund was to be diversified, appropriately ducking the definition of diversified. However, they concluded that for a fund to be classified as diversified it had to have a minimum of 20 positions. While one can argue how much each position contributed to diversification, 20 seems a reasonable number. (In our private financial services fund we have somewhat less but we have wide economic diversity.)

Most equity funds currently have under 100 holdings, except the large funds that are forced to own multiples of 100 because they do not wish to own 5% of the voting shares of companies. (Counting all positions in our various personal accounts, we hold almost as many funds as stocks in a diversified domestic portfolio, although many of the funds are international funds.)

Some large institutional investors have limited investment staffs and multi-billions to invest. Their solution is to own the “market”, which they define as the Standard & Poor’s 500, containing most of the large and larger mid-cap companies. In many cases they use an index fund to fill this need. Others seek broader representation through replicating the Russell 2000 or 3000. Again, usually using index funds.

Some investors want to limit their stock commitment to the same percentage as in an index. For our accounts we use the stock weighting as an important tool in managing risk and return in a portfolio. Due to price appreciation, there have been instances where a single stock has grown to represent 20% of a portfolio. Again, due to appreciation we regularly have a few positions of over 10%. We rarely buy more of a position weighted over 5%. In some long-term accounts we own starter positions in stocks to get a “feel” for how they trade and treat their small shareholders. Some of these small positions stay with us for a long time, either because we need more convincing, or our timing was brilliantly wrong.

Question of the Week:

Does the number of positions in your accounts change much?

What if anything does the number tell you about your investments? 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.